By Mark Martin, manager of the Neptune UK Mid Cap Fund, and Scott MacLennan, manager of the Neptune UK Opportunities Fund
H1 2014
• Equity markets continued to show strength: despite a strong rally in 2013 driven by a market-wide re-rating, equity markets continued to generate positive returns for investors. Economic activity continued to be stimulated by accommodative policy from both central banks and political bodies. This has aided the progressive repair of economies affected by the financial crisis and supported the improving outlook for global growth. In addition, despite no longer appearing cheap in absolute terms, equities remained attractive relative to other asset classes.
• Selling the winners, buying the laggards: there was a noticeable internal shift within the UK equity market that saw investors move away from the ‘winners’ of 2013 into sectors and stocks that underperformed in the same period. Areas of the market that performed strongly last year on the back of a buoyant outlook for the UK economy, namely the housebuilders, building merchants and retailers, started to come under pressure in the first half of the year as the market brought forward expectations of a rise in UK interest rates. Consequently, the market focused its attention less on domestic cyclical exposure found within the FTSE 250, in favour of more diversified, overseas earnings sources within the FTSE 100.
• Early- to mid-cycle rotation: momentum in domestic cyclicals slowed as UK interest rates looked set to rise and investors reduced their sector allocation away from early-cycle exposure, mostly found through industrials and consumer discretionary, into later-cycle sectors, like energy and materials. This would tally with the likelihood of a rise in inflation expectations, given improving employment dynamics and the possibility of a return to real wage growth in the UK.
H2 2014
• Equities are still a relatively attractive option: although absolute valuations have increased markedly over recent years, parts of the equity market remain attractive relative to many other asset classes. Ongoing de-leveraging continues to be a headwind for western economies and companies with structural growth opportunities are likely to be increasingly sought out.
• Wide range of potential outcomes from global monetary policy experiment: the ability of the global economy to withstand higher interest rates will be critical for H2 2014 equity returns. Earlier-than-expected interest rate rises may cause volatility but ultimately represent economic recovery and should benefit equity markets. The resilience of UK exporters’ profits is likely to be tested by the strength of sterling. We would continue to advocate a balanced, diversified approach, incorporating as diverse a range of equity exposures as possible.
• Corporate activity: we are continuing to focus on attractively valued companies that are set to benefit from structural growth trends or a significant level of internal self-help/management change. In the absence of organic growth opportunities, well-funded companies may look to return excess cash to shareholders, or to mergers and acquisitions (M&A) to grow sales and profits. Pfizer’s approach for AstraZeneca, as well as several lower profile deals, bears witness to the renewed corporate appetite for M&A.
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